Young Associates is thrilled to be partnering with WorkInCulture to launch Take the Lead: Principles for Administrative Leadership for the Arts, a new two day seminar series for increasing managerial and governance skills in arts administration. Running October 12 & 13, 2017, instructors from Young Associates and WorkInCulture will deliver sessions on understanding financial statements, payroll, WSIB, and HR. Get more details here.
Should my company capitalize and amortize the costs of sets and costumes?
Capital assets generally include items of significant value that are owned for longer than a year, and used in operations. Spending on production can vary widely from show to show and company to company. If you are spending significant sums in these areas, it’s worth exploring this issue.
Let’s take the example of an opera company that has adopted an accounting policy of capitalizing its sets and costumes and amortizing them over 7 years, based on the fact that it draws from a “canon” of works, and therefore remounts shows from time to time.
One way to look at capital assets is as a deferred expense. You pay all the bills in Year 1, but (through amortization) you recognize the expense over the estimated useful life of the asset (in this example 7 years), so that each year of use bears its proportional estimated share of the cost (in this example 1/7 per year).
The argument in favour of capitalizing and amortizing sets and costumes would be that you expected to use them actively over the estimated 7 years, either in your own shows or as rental properties.
Let’s work through the accounting effect, step by step. In the first year of adopting this policy, you would record your sets and costumes as assets, not expenses. This would have the effect of improving your bottom line. You would of course need to record one year of amortization expense – that is, 1/7th of the purchase price. The remaining 6/7ths of the expense would be postponed to future years.
Onward to Year 2, and a new year of programming with (potentially) a new group of directors and designers. Will those artists be content to reuse Year 1’s sets and costumes? It seems likely that, in most cases, while they may reuse some “stock” items, they would prefer to create something new and different. In that instance, the company would incur new expenses for set and costume purchases. Once you set up an amortization policy, you need to follow it -- so you would amortize Year 2’s production items in the same way. Financially, the result would still feel pretty sweet, because in this year you recognize the cost of 1/7 of Year 1 purchases plus 1/7 of Year 2 purchases... but you can see where this is heading.
By the time you hit Year 7, the bottom-line advantage has disappeared because you've got seven active amortization cycles. You're also saddled with a certain amount of extra bookkeeping – and, more importantly, production expense becomes difficult to interpret. Imagine looking at the Year 7 income statement. You know for a certainty what your box office revenue was, but because related expenses and revenues are no longer matched within a fiscal period, it becomes trickier to interpret the financial result. The set and costume expense in Year 7 does not capture the cost of Year 7 shows, but rather 1/7 of the costs for each of the previous seven years.
The real "bottom line" to this story is that you can't out-run expense. You need to recognize it sooner or later. Our opera company might have been tempted to adopt the amortization policy as a gambit to improve the bottom line at a point when things weren't going well – but over the longer haul this approach doesn't put you any further ahead.
Now – let’s look at the other side of the coin. If you expense sets and costumes during the year of the show for which they were created, expense recognition is clear. That's very helpful for the purpose of evaluating financial results. But, it's also true that companies, especially larger companies in the opera and ballet worlds, DO remount productions and rent productions to other companies. If you don't amortize the cost, those future uses have no cost attached to them – and the financial statements for those years could be seen as misstated by the amount of expense that perhaps should have been attributed to them.
Expensing items in the year of the production means that companies may own a lot of stock – sets, costumes, props, etc. – that's not acknowledged on the balance sheet as an asset. However, that is how the set and costume expense is typically handled, in the experience of Young Associates staff.
The question for management is which treatment best reflects the company’s financial results? And, which treatment best applies generally accepted accounting principles (GAAP) such as cost-benefit and materiality? Managers need to evaluate whether the advantage of matching revenue and expense recognition outweighs the possible misstatement of future bottom lines.
This would be an excellent topic to discuss with your accountant.
Click here for more q and a's on capital assets.
At what point would our accumulated surplus be so large that we’d be in trouble with the Charities Directorate?
The Charities Directorate of the Canada Revenue Agency does, indeed, have rules around accumulation of property. The particular rule that charities are probably thinking about if they’re worried about the size of their accumulated surplus is the disbursement quota (DQ). The purpose of the DQ is to establish a minimum requirement for spending on charitable activities, with reference to the wealth that a charity has accumulated. As long as you maintain an appropriate level of charitable activity – measured through your spending – you are compliant with this rule.
CRA provides guidance about its spending requirements here. Note that there are separate rules for charitable organizations, which exist to deliver charitable programs and services, and foundations, which exist to support charitable programs and services.
Young Associates works with many smaller charitable organizations. Most groups in this category are unlikely to have accumulated property at a level that would cause non-compliance with the CRA. However, this is an issue that may involve complex legal and financial concepts. If you have concerns, it is wise to discuss your situation with a professional.
CRA defines its requirement for charitable organizations as follows:
If the average value of a registered charity's property not used directly in charitable activities or administration during the 24 months before the beginning of the fiscal period exceeds $100,000, the charity's disbursement quota is:
3.5% of the average value of that property.
The interpretation of this hinges on what property is not used directly in charitable activities or administration. CRA lists real estate and investments as examples.
A charity, for instance, may hold long-term investments such as units in a mutual fund, and use the resulting interest revenue in its operations. However, the principal sits intact for multiple years, not directly used for charitable activity. (This is distinct from the case of a charity that places short-term investments to earn some interest revenue before the investment matures and the principal winds up in a chequing account, available for spending.)
A charity may also own a building that it doesn’t currently occupy; this may be the case for institutions such as hospitals, universities and churches, which may have considerable real estate holdings and needs that change over time.
Once you have identified property that meets CRA’s definition of “not used directly in charitable activities or administration,” you must calculate its average value over the two years before the start of the current fiscal year. CRA provides some latitude in how the average may be calculated. If your organization needs to make this calculation, the method for assessing value and calculating the average over time would be a good topic for discussion with your CPA.
Last step: calculate 3.5% of the average value. That yields the amount your organization is obliged to spend on its charitable activities or administration during the current year.
Let's say your charity owns an investment portfolio, and you determined that its average value over the last 24 months was $100,000. Your DQ for the current year would therefore be $3,500.
You can see that this is actually a pretty low bar to jump over! Most organizations with the capacity to build a $100,000 investment portfolio would have operations that demanded more than $3,500 in program and admin spending. CRA’s rule is set at a level that catches inactive charities, but that is unlikely to cause compliance issues for most charities that are actively carrying out their mandates.
You Can’t Outsource Financial Responsibility (Chickens Always Come Home to Roost.)
Staff Post
By Heather Young
I often teach and consult for artists and arts managers who have limited background in accounting and finance, and who therefore are reluctant (or even fearful) to step into this arena.
The bad news is that, like all relationships, it’s a package deal - once you take on a management role, you must accept decision-making responsibility, even in areas that aren’t your greatest strength. The good news is that there are some simple techniques that will help you feel more comfortable in the driver’s seat, whereas failing to make the attempt (no head for this sort of thing, terrible with numbers… you’ve heard the excuses) can set you on course for disaster.
Case in point: a certain executive director was meticulous in the artistic/programming side of their role; not a detail escaped their attention. And yet, with no apparent irony, the ED declared their inability to do math and therefore complete dependence on the part-time bookkeeper to deal with day to day finances. Financial statements? That’s what the accountant prepared for the government. The ED complained about receiving terrible service, but had trouble articulating the problems or what improvements were needed.
This didn’t stop them from blundering ahead with ill-conceived financial decisions, often based on phone advice from a couple of more economically successful artistic colleagues, and at odds with the advice they were paying for. Later, they would turn to the accountant or bookkeeper to clean up the mess… while making it clear they didn’t want to hear the mechanics of what went wrong. In their view, poor results arose from poor execution by the contractors: “Not my job; just fix it.”
No wonder they felt angry and mistrustful: they didn’t know how to collaborate with accounting staff, let alone tell whether they were doing a reasonable job. And staff heard the unspoken message: there’s no point getting into it with the boss.
Don’t be that guy!
Henry Ford got it right: "One of the greatest discoveries a man makes, one of his great surprises, is to find he can do what he was afraid he couldn't do."
Sit down with your bookkeeper or accountant and review your statements together. Ask them to walk you through the important points. Do it every month. You know your organization; financials are just another way of telling its story. You’ll soon start to recognize features that indicate whether you’re on track financially. If your staff member can’t explain the numbers with confidence – well, maybe it’s time to get a second opinion on the quality of their work.
Expand the conversation with a few good questions, such as:
Are we compliant with the CRA? Can you walk me through our latest remittances or returns? (Your bookkeeper should be able to explain how amounts are calculated and reported to the government.)
When was our most recent bank reconciliation, and can I see the list of outstanding items? (Bank recs prove that cash is stated accurately, and they normally happen monthly. It’s unusual for online or ATM transactions to be outstanding, and uncleared cheques should be recent. In Canada, cheques are stale-dated after six months.)
Are there any particular areas of concern? (This depends on your situation, but you should have a sense of whether the explanation matches your observations.)
You can be a capable financial manager without being an accountant. Some “due diligence” with the financial statements will strengthen your working relationship with accounting staff, and generate that priceless reward, ease of mind.
Read about the Canada Council's new funding model here
In December, the Canada Council published their newly redesigned funding model, with which they hope:
...to more strategically support the creation and wide dissemination of excellent Canadian artworks, to more directly and efficiently support Canadian artists, and to more flexibly and effectively support the development of a diversity of high performing arts organizations.
A year ago, the council announced its plan to move away from its pre-existing model, one which was based around artistic discipline, and streamline its funding structure with a goal to more effectively serve grantees and the arts community. The new model is composed of six new programs:
- Creating, Knowing, and Sharing: The Arts and Cultures of First Nations, Inuit and Métis Peoples
- Explore and Create
- Engage and Sustain
- Supporting Artistic Practice
- Arts Across Canada
- Arts Abroad
You can access information about the six new programs, their objectives, candidate and entrance activity requirements, the maximum grant allowance, application deadlines and assessment criteria here: newfundingmodel.canadacouncil.ca and you can email the Canada Council at info@canadacouncil.ca or call them at 613-566-4414, ext. 5060 if you have questions.
Canada Council developing new funding model
Staff Post
By Anna Mathew
The Canada Council for the Arts has just announced that it is "moving towards the implementation of a new suite of national, non-disciplinary programs", which will reduce the number of funding programs significantly. The Council indicates a number of motivations behind the changes, including increased flexibility and a lessened administrative burden on artists, arts administrators, and Council staff. The Council is working towards a 2017 implementation schedule, with specific plan announcements to be made in summer 2015.
Read more about the Council's announcement on their website.
Update: Read about the New Funding Model
